Which of the following statements about the Price/Earnings ratio is not correct?

ID: 2490272 • Letter: W

Question

1.If the market price of the stock increases and there is no change in EPS, the Price/Earnings ratio will increase.

2. A high Price/Earnings ratio may mean that investors have pushed the price of the stock up in anticipation of higher future net income.

3. The Price/Earnings ratio indicates how much investors are willing to pay for a share of a company's stock as a multiple of current earnings.

4. If EPS decreases and there is no change in the market price of the stock, the Price/Earnings ratio will decrease.

The correct answer is option D.

If the EPS decreases and the market price remains same then the price earning ratio will also increase.

P E ratio = Market price of the share / EPS

Let us say market price is 100 and EPS is 10 by substituting the PE ratio = $100/$10 = 10.

now the EPS decreased from $10 TO $5 AND THE market price remains at $100.

Then the PE ratio = $100/$5 = 20.

Therefore, the PE ratio increased, when the EPS is decreased and no change in market price.

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